Credit Freeze Overwhelms Monetary Easing

Monetary easing in Asia and massive U.S. bank borrowing from the Federal Reserve did little to calm the panic in credit markets at the epicenter of the global financial crisis.

Overnight interbank borrowing rates eased after central banks around the world cut interest rates earlier this week, but they held well above target rates in Asian trade on Friday. Longer-term funding costs also remained stubbornly high despite the unprecedented act of global coordination.

Analysts say that at the heart of the money markets squeeze is a crisis of confidence and fears of bank failures, concerns that central bank cash injections and rate cuts can only partially address.

"We're not seeing any relief in term LIBOR (London Interbank Offered Rate) fixings, which tells us that the rate cut has exclusively impacted on the overnight market, but it hasn't touched the LIBOR market at all," said BNP Paribas rate strategist Alessandro Tentori.

"And that's not a very good sign," he added.

Singapore eased its monetary policy for the first time since 2003, declaring that it would slow the appreciation of the Singapore dollar, which is managed against a basket of currencies.

The monetary loosening will cushion the impact of the global crisis, but Singapore's export-dependent economy, officially in recession after two quarters of contraction, could keep shrinking well into 2009, analysts said.

The Reserve Bank of Australia injected A$2.63 billion (1.06 billion pounds) into the banking system on Friday, adding about A$790 million (467 million pounds) more than the estimated need in an effort to ease funding pressures.

But like other central banks, Australia's central bank has been frustrated by money markets despite its generous cash injections and its aggressive 100 basis point cut in the cash rate earlier this week.

The three-month LIBOR for the Australian dollar widened to 142 basis points above the 6.0 percent cash rate, the biggest gap ever, showing just how reluctant banks are to lend to one another.

In China, a freezing up of money market lending drove money into government debt, pushing yields of three-year government bonds offered at a an auction much below expected levels, traders said.

In a new twist, investors in Japan dumped normally safe-haven government bonds in a rush to secure cash and gold.

"Worries about counterparty risks have frozen up the money market, and that has pushed short-term JGB yields up," said Tetsuya Miura, a bond strategist at Shinko Securities. "We can call this a new type of bad yield rise."

Costly Term Borrowing

U.S. banks borrowed a record $420 billion per day from the Federal Reserve in recent days as financial institutions continued to rely on the lender of last resort.

Banks' discount window borrowings for the week to October 8 topped the high set in the previous week and were greater than the size of the economy of Belgium.

High bank-to-bank lending rates have stymied funds from flowing into other parts of the money markets such as commercial paper, which continued to contract despite support from the Federal Reserve.

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While lower overnight interest rates will prevent further deterioration in the global credit crisis for now, elevated term borrowing costs will hurt cash-strapped companies and consumers in the long run, according to analysts.

The British Bankers Association's latest daily fixing of London interbank offered rates, which are global rate benchmarks, showed the cost of overnight dollar, euro and sterling funds fell less than a half-percentage point.

That was the size of rate cut delivered by the Federal Reserve, European Central Bank and Bank of England on Wednesday as central banks around the world acted in unison to fight the deepest financial crisis in 80 years and stave off recession.

Overnight dollar funds were quoted between 4 and 7 percent in Singapore, 4.5-5.8 percent in Bangkok and 4-5 percent in Jakarta, close to Thursday's overnight LIBOR rate just above 5 percent and well above the U.S. Federal Reserve's new 1.5 percent target rate.

Three-month dollar rates in Asia were quoted between 4.5 and 7 percent. The three-month dollar LIBOR was fixed at 4.75000 percent on Thursday, its highest this year.

Copyright 2008 Reuters. Click for restrictions.